Does Japan really win from commodity inflation? | FT Alphaville

Does Japan really win from commodity inflation?

Growing concern in Asia that Middle East turmoil and soaring oil prices will deepen the region’s inflationary struggles has also prompted some debate on whether Japan would actually benefit from a nice little bit of inflation.

Indeed, the WSJ recently argued in favour, noting that the cost of Japan’s imports jumped 4.7 per cent in January year-to-year, in yen terms – the sharpest increase since July, according to the Bank of Japan. The upshot — a slowdown in the pace of Japanese deflation.

However — not in the view of some commentators, who weighed in on Friday to dismiss the notion. As Macquarie Securities noted:

We disagree with the view that deflation means Japan is the one country to benefit from higher oil prices. In the previous commodity boom, profits peaked in 1Q07 and domestic demand in 2Q07 as higher commodity prices pushed the economy towards recession well before the Lehman’s collapse.

Masamichi Adachi,  economist at JPMorgan in Tokyo, reinforced the point:

Some commentators argue that the rise of commodity prices is welcome in Japan, which is suffering prolonged deflation. We disagree with this view. While the rise in food and energy prices may increase households’ inflation expectations, it does not mean that they can expect higher wages in the future. Actually, in a deflationary environment with considerable slack, the opposite will likely happen as the profit squeeze will weigh on wages, further restraining labor income and consumption. The deterioration in the terms of trade—resulting from a rise in import prices and a fall in (or flat) export prices—may be the drag on domestic demand, which is still sluggish and fragile.

On the broader question of the impact of oil price spikes on Asia, Macquarie says the impact on Asia would come through a variety of channels, it adds:

A supply shock to oil prices would affect Asian economies through two basic channels. It is different from a demand-driven rise in prices, which tends to have some self-correcting elements. First, there is a terms-of-trade shock that depresses demand in oil importers via an income transfer to oil producers and this hurts global demand as the producers tend to have a relatively low propensity to spend their windfall gains.

There is also the risk of an inflation shock. This is particularly the case in lower income economies where fuel has a higher weight in consumer spending, and which are institutionally more prone to second-round effects.

Most of the region would be hurt through the terms-of-trade effect… Even the impact on the energy-exporting economies is equivocal, as fuel subsidies hurt public finances…

In terms of currencies, higher oil prices are negative for the dollar but not for the yen, says Tohru Sasaki, currency strategist at JPMorgan in Tokyo.

While many investors may think instinctively that a higher oil price is negative for the yen – based on the logic that it would cause Japan’s trade balance to deteriorate – Sasaki argues there is “almost no correlation” between oil prices and Japan’s trade balance. He explains:

Japan’s trade surplus plunged 81% in 2008 when the oil price surged 50% to 145 dollar/barrel in the first half of the year. This was caused by the combined effect of an 8% increase in imports and a 3.5% decrease in exports. [Yet] Japan’s trade surplus increased 37% in 2007, at the same time that oil prices surged 56% throughout the year. This suggests that if there is an oil price rally against a backdrop of a strong global economy, strong export growth will overpower the negative impact from a higher oil price.

As a result, the effective JPY rate also has almost no correlation with oil prices. Meanwhile, there is a moderate correlation between oil prices and USD. Higher oil prices seem to be USD negative
via concerns over inflation. Indeed, inflation expectations… are correlated with the effective USD rate in the long-term. This is not surprising, as higher inflation expectations should lead to lower real interest rates in the US, which should affect the dollar negatively.

Regardless of where the yen, the dollar and Japanese deflation goes in the near term, something tells us that Tokyo is not looking forward to further oil price rises.

Related links:
Libya, the Asian fall-out – FT Alphaville
Oil price signals difficult time for the yen – FT
Nomura’s $220-a-barrel crisis call – FT Alphaville
Why fuel prices and food costs are going up – BBC